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Exchange Rates

Exchange Rates. The value of one country’s currency in terms of another country’s currency. 1983 Australia changed to a flexible exchange rate (floating exchange rate) Forces of demand and supply on FOREX (foreign exchange) markets determine the exchange rate. Trade weighted Index.

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Exchange Rates

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  1. Exchange Rates • The value of one country’s currency in terms of another country’s currency. • 1983 Australia changed to a flexible exchange rate (floating exchange rate) • Forces of demand and supply on FOREX (foreign exchange) markets determine the exchange rate.

  2. Trade weighted Index • Measures movements in the exchange rate compared to major trading partners • Over the last 5 years the AUD has been appreciating relative to the US$ + TWI • Graph the AUD relative to the US$ and TWI over the last 8 years – page 126 • what is the AUD exchange rate today?

  3. Depreciation • decrease in value of currency • $1AUD= $1US • $1AUD=$0.90 US • Why does a depreciation occur? • Use demand and supply diagrams

  4. Depreciation – positive effects • Increase international competitiveness – export prices can fall and import prices can rise. The impact of this will depend on the price elasticity of demand for exports and imports. WHY? • CAD should improve if X growth increases. • Encourage foreign investment • Increased economic growth rates.

  5. Depreciation – negative effects • Increases interest servicing costs for funds borrowed from overseas- valuation effect - increases CAD • Increases the Foreign debt in AUD for those that have borrowed from overseas – valuation effect • Increased domestic inflation as import prices increase. • A large and sudden depreciation may prompt RBA intervention. NOTE: an appreciation has the opposite positive and negative effects

  6. Appreciation • What is an appreciation? • Why do currencies appreciate? • What are the positive effects? • What are the negative effects?

  7. Summary • Overall a depreciation is generally considered good by exporters because it increases international competitiveness and bad by those that have borrowed from overseas or are travelling overseas.

  8. Role of RBA • RBA intervenes in FOREX markets from time to time to stabilise the currency- this is called dirtying the float. • Direct RBA intervention can only be a short-term • RBA intervention can also be indirect via domestic interest rates

  9. Fixed or Managed exchange rates • Some countries attempt to manage their exchange rates- Singapore and China • The central bank buys or sells currency to maintain stability in the market • Managed currencies tend to discourage currency speculators

  10. Revision • Complete the multiple choice and short answer question. • Complete questions 1-10 from text page 135 • Discuss the effects of an appreciation of the Australian dollar on Australia’s internal and external stability.

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